Income Protection v Critical Illness: The key issues

Around half a million people each year purchase critical illness cover which compares to around 100,000 buying Income Protection.

This means that, in the UK, Critical Illness Cover outsells Income Protection by a factor of approx 5 to 1.

The main reasons for this gap are fairly well known and include:

1. Most people prefer a lump sum benefit to an income
2. Income Protection is more complicated to underwrite
3. Critical Illness is an easy add-on to life cover
4. Income Protection suffers (unjustifiably) from comparisons with PPI.

In an ideal world the benefits complement each other as they represent different risks. Critical Illness cover typically provides a lump sum in the event of a potentially life threatening illness or covered major illness, while Income Protection pays income if you cannot work until you either can work or retire. You could look at it in fairly simple terms that one pays off the debts while the other pays the ongoing bills.

But for many people affording both is a luxury.

So let’s take a look at the key issues.

1. Design and history

Critical Illness cover was designed as a major medical expenses plan back in the 1980s. It was developed in South Africa to allow people to pay for life saving operations and treatment, which many could otherwise not have afforded.

In the UK, however, with the National Health Service in place, the product found success being advised as an add on to compliment life insurance primarily as mortgage protection cover so that if you suffered from a heart attack, cancer or a stroke you may be able to pay off your mortgage.

While this can offer significant peace of mind, some advisers don’t feel that it goes far enough and instead argue that Income Protection offers more comprehensive cover; even for mortgages.

Income Protection, formerly known as Permanent Health Insurance, is a long-term insurance policy that pays out if an individual is unable to work due to injury or illness, and has been described by Which? as the one protection policy every working adult in the UK should consider.  However, it is the very one most of us don’t have!

2. Scope of cover

In theory Income Protection covers all medical conditions. Unlike Critical Illness there is no ‘list’ of insured illnesses, so the only important factor is simply whether or not you can work.

So why do I need Income Protection if I’ve got Critical Illness cover?  Take a look at the chart below which identifies some of the claims made:

3. Windfall payments

There are some so-called ‘windfall’ CI payments where people are paid a huge lump sum having already returned to work. On the flip side half of all heart attacks are repeat attacks where most people return to work within 6 months of the first incident due to financial pressures.

Does IP help here? If the policyholder returns to work within the deferred period the policy would pay nothing, where as CI would likely have paid out upon diagnosis of the heart attack, removing the financial pressure to return to work and reducing the risk of a second heart attack.

Mark Jones at LV argues: “The cover that someone needs will very much depend on their individual financial and personal circumstances. Speaking to advisers it’s clear that some clients think it’s a case of ‘either or’ when it comes to income protection and critical illness cover, however there is a significant difference between the two products.

“Critical illness cover will pay out if a client suffers a serious illness; if it’s an accelerated product it also pays out on death. If a client is unable to work but not as a result of a critical illness e.g. they break their leg or suffer a back injury, without an income protection policy in place, they could find themselves in a financially vulnerable position.”

4. Rehab and other features

Many IP plans provide rehabilitation and other forms of benefit aimed at getting people back to work quickly. While this can reduce the amount paid out in claims, it often also reflects what the policyholder really wants, which is to be fit enough to be able to work.

Both Income Protection and Critical Illness plans can also offer a range of other benefits including counselling, second opinions, discounts for healthy lifestyles and more.

Phil Jeynes of PruProtect, said: “Whichever type of cover you take these additional benefits and options are an important consideration that can help to save money and also improve the overall level of cover.”

5. Perception

Critical Illness helps to remove immediate financial stress and potentially pay for treatment (and even lost income), but something worth bearing in mind is that there’s not much point paying off the mortgage if you can’t afford to live in the house.

The point being that there are many bills that still need paying, even if the mortgage or rent is no longer an issue. This is where Income Protection comes into its own.

6. Claims stats

Thankfully both products have very good claims paid rates these days, with insurers typically reporting paid claim rates in excess of 90% for both Critical Illness and Income Protection.

7. Getting it right

There are situations where Income Protection would have been better than Critical Illness but also vice versa – it all depends upon what happens to you of course.

Hindsight is a wonderful thing and which product would be better for you is retrospective. We don’t know what will happen in the future so all we can do is ensure that we are financially secure should the worst happen, which is where advice can be essential.